LPC: Petsmart's loan under pressure after weak 3Q earnings

NEW YORK, Dec 15 (Reuters) - Pet supplies retailer Petsmart’s US$4.2bn leveraged loan has fallen in the US secondary market after the company reported sluggish third quarter results on Monday and investors anticipate a weak fourth quarter, two sources close to the matter said.

The loan has fallen by around seven points to 77 bid this week, compared to 84 bid before Monday’s earnings release, the sources said. Weak earnings have pushed the company’s debt-to Ebitda ratio up to a whopping 6.2 times on a secured basis and to 8.7 times total.

The loan, which was arranged in 2015 to back Petsmart’s leveraged buyout by a consortium of private equity firms led by BC Partners, is due to mature in 2022 and pays 300bp over Libor with a 1% Libor floor.

Petsmart does not file financials or hold public earnings calls. The company reported US$2.3bn in revenue for the period ending October 31, showing a 30% year-over-year increase, from US$1.8bn, the sources said.

The gains were attributed to Chewy.com, which the company acquired for roughly US$3bn in May to give it an edge in the growing e-commerce landscape and prop up its brick and mortar operations. To be sure, revenue at Petsmart’s legacy business slipped by 1.5%.

However, the combined company’s Ebitda sank 34% to US$189m, from US$288m a year earlier, driven by negative Ebitda at Chewy that has been exacerbated by ongoing costs related to growth initiatives and customer acquisition. Petsmart’s standalone Ebitda fell 15%.

“The company is draining cash out of existing Petsmart to fund Chewy,” one of the sources said. “It’s the Amazon model – Amazon takes money from the cloud business to fund the retail business.”

The company’s debt includes the term loan, a US$1.35bn secured note used to fund the Chewy purchase and US$2.55bn of unsecured notes, US$650m of which was also used to fund the Chewy deal.

BC Partners and the company declined to comment.

The pressure on the loan stems more from a knee-jerk reaction to management’s comments on the earnings call than the company’s most recent performance, the sources said.

“Everyone knew Chewy was a negative Ebitda company,” the same source said. “You can’t turn it around instantly, or you’d stunt growth.”

Investors have been expecting positive revenue comparisons in the fourth quarter, which they say should be achievable as the company has moved past its failed negotiations with Colgate-Palmolive over mass distribution of its Science Diet pet food in the fourth quarter of last year. Fallout included Petsmart pulling the product from its shelves and delivering a roughly 5% slump in revenue.

“Three quarters of the decline was due to Colgate,” the source said.

More recently, another of the company’s suppliers, pet food maker Blue Buffalo, also decided to shift to mass distribution.

Though asked, management held off on the earnings call on Tuesday from providing insight into fourth quarter revenue, telling investors it would be addressed on the next call, the sources said.

Investors also asked management whether the private equity owners could use the restricted payments and permitted investments basket in the debt documents to separate Chewy from Petsmart and take control of the business, but management declined to answer the question.

“They wouldn’t talk about it,” one of the sources said.

The restricted payments basket is tied to net income and proceeds from equity issuance. The capacity grew with the Chewy transaction, as financing included a US$1bn equity check from shareholders. (Reporting by Andrew Berlin; Editing By Tessa Walsh)